Memo 25 – Market View – Who shall pass the litmus test?

Let us start this note with the small caveat that we usually put at the end of all our articles – “Equity as an asset class can be extremely rewarding in the long term. However, only those individuals who can bear the interim volatility should invest in equities”. After almost four years of relatively smooth ride, this “interim volatility” is very much here and this could well be the litmus test of the investor in “you”.

The reason for terming this phase as litmus test is because this will be the first time in past four years that you will see losses in almost any kind of investments that you would have made – stocks, bonds, real estate, cryptos, start-ups and land. Let us provide some numbers so that you can grasp the context of all this:

• Crypto currencies: The party is clearly over for now (mentioned in our memo dated 15th Dec 2017 note Bitcoins – Better or Bitter?) and Bitcoin has lost 65% of its value from peak. For others, the losses have been worse and cases of suicides have come to fore.

• Real Estate: After being slow for many years, it just got worse. Prices continue to drift south-wards and sellers are unable to liquidate their properties even after offering good discounts. It’s a slow grind here for sellers as well as rent seekers.

• Bonds: Many of you would be investing in bonds through debt or liquid mutual funds. Since the interest rates in India have seen a sharp rise, the three year returns in many of them have become less than 5%, effectively being lower than inflation.

• Stocks & Mutual Funds: Approximately 750 of the 800 investment grade stocks have declined by 20-50%. As a result, many stock portfolios and mutual fund schemes are down 10% to 20% during the last nine months.

What can you do?

Since many of you would have started equity investing only in the last few years, you may be witnessing capital losses to the tune of 10-20% for the first time. Losses have a profound impact on the human brain as shown by many scientific studies:

• The pain from losses is almost twice more than the pleasure from gains.

• The reflexive part of the human brain reacts to losses in a similar way as it would react to life threats and force you to react.

The above is the precise reason why we believe that this backdrop will serve as the litmus test towards your relationship with equities. Just like healthy relationships, jobs, policy decisions, equity investments give best returns in the long term but human brain is naturally tuned to react to near term events. At such times, it always helps to look back at the history for the valuable lessons that are hidden there:

• Older investors will recall that such things have happened four times over the past twenty years – the Asian crisis of 1997, the post dot-come meltdown period of 2003, the Lehman crisis of 2008 and taper tantrum of 2013. Despite this, Indian economy has grown 7 times over the past twenty years.

• This is not the first time or the last time that stocks will be down. It is the very nature of the market. You cannot change this, but the only thing that you can change is your reaction to the interim volatility.

• Willingness to wait longer than other people is your biggest natural edge. If you can think about the next five years while everyone else is fixated on the next five months, you have a huge advantage!

• There’s no such thing as a normal market or a normal economy. Some people spend their lives “waiting for things to get back to normal” without realizing that stocks and the economy are always in some state of craziness.

What has led to such a situation across assets classes?

Markets take cues from multiple global and local factors most of which are unpredictable. The rising oil prices, the unusual strength in the US economy resulting in rising interest rates, Trump trade wars and global risk aversion towards emerging markets have largely contributed to all this. However, for the first time in last twenty years, we are tempted to make a statement that most of the things impacting India are external in nature.

Indian economy remains well placed to face this storm. Not to say that we won’t be impacted, but India’s improving economic activity, robust fiscal & trade position and lower reliance on foreign debt will ensure that the damage will be much lesser than witnessed in 2013. USD/INR at 72, interest rates at 8.2% and petrol at INR 100/litre surely do not mean an end to the India story.

Which sectors/ themes do we like?

While some re-balancing of the portfolio is inevitable given the changing macro variables, the long term business prospects of most of the sectors we have discussed in the past remain robust. We remain excited about positive developments happening in the rural, real estate development, NBFCs and dairy sectors. Debt heavy sectors like infrastructure, power, PSU Banks, aviation, etc are best avoided.

Markets may not fall sharply from here but upside movements are more likely to be stock specific. The short term looks uncertain, especially in the light of upcoming elections. However, this uncertain period will give opportunities to invest in great businesses at reasonable prices. You should stick to your long term plan – invest regularly, have reasonable expectations and have a long term outlook.

Trivia – the nutrition flip-flop

Never have we seen so many people being obsessed with healthy eating & living as in the recent few years – office colleagues suggest cutting out carbohydrates from the diet, gym colleagues recommend increasing proteins, and the supermarket stores sell fat free products. Despite all this, people just seem to be getting unhealthier with lifestyle diseases on a rise.

After watching some documentaries, were surprised to know that nutrition science has first made a hero and then a villain of the same food over a period of time! Early 1900s was an era of promoting processed carbs which were fortified (added vitamins). That led to huge increase in corn farming and the birth of breads & cornflakes. By 1970s, suddenly fat was responsible for all heart issues, whereas dairy & animal proteins acquired the essential tag. This started the popular fat free food era. By late 2000s, butter is back in fashion, majority of carbs are required to be shunned after 7pm. Protein (Keto) diets having become the saviours and Gluten (from wheat) is now an allergy.

While we are no experts at this, it is quite hilarious that despite the cutting edge progress on information technology we boast about, we are more confused than ever before due to overload of information. To add to the above drama, a family relative lost 10% of her weight after she re-started eating ghee and traditional food in a big way. This was the same person who stopped applying ghee on rotis since the age of 14 (courtesy, western nutrition science) and only gained weight through her next twenty years.

While we can write pages on the science behind this weight loss, the point is very simple – information overload forces you to focus too much on recent trends and forget the bigger picture. This has implications on your physical as well as financial health. A balanced approach will always lead to better outcomes – too much of any asset class is not a great idea – too much of real estate or fixed deposits and too little of stocks or vice-versa isn’t a great idea.

Feel free to reach out in case you need professional help with your investments!

P.S: Equity as an asset class in extremely rewarding in the long term, however, only individuals who can bear interim volatility should invest in stocks. Kindly consult your investment advisor before acting on advice provided here.